Climate Economics Seminar: Intergeneratonal Discounting

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Description: Dr. Pizer discussed the challenges of discounting benefits and costs of policies that occur over multiple generations. He is a recognized expert in the economics of energy and climate change. His remarks on intergenerational discounting focused on his 2003 analysis with Richard Newell of incorporating uncertainty about discount rates on estimates of the benefits of reducing greenhouse gases. This article, the abstract of which is provided below, was awarded the Petry Research Prize for the economics of Climate Change by the Association of Environmental and Resource Economists.

Paper abstract:
The authors demonstrate that when the future path of the discount rate is uncertain and highly correlated, the distant future should be discounted at significantly lower rates than suggested by the current rate. They then use two centuries of US interest rate data to quantify this effect. Using both random walk and mean-reverting models, we compute the ‘‘certainty-equivalent rate’’ that summarizes the effect of uncertainty and measures the appropriate forward rate of discount in the future. Under the random walk model they find that the certainty-equivalent rate falls continuously from 4% to 2% after 100 years, 1% after 200 years, and 0.5% after 300 years. At horizons of 400 years, the discounted value increases by a factor of over 40,000 relative to conventional discounting. Applied to climate change mitigation, they find that incorporating discount rate uncertainty almost doubles the expected present value of mitigation benefits.